By Debashish Majumdar (’06 CHEMICAL)
In our quest for sustainable development with a view to protect the environment, we have to heed the warning signs of global warming. In this context, carbon credits have become an important tool for environmentalists, nations, traders, corporations and even farmers. They derive their name from the emission of one of the most significant greenhouse gases, carbon dioxide. But what exactly are they?
Carbon dioxide, the most important greenhouse gas has become a cause of global panic as its concentration in the Earth's atmosphere has been rising alarmingly. This devil, however, is now turning into a product that helps people, countries, consultants, traders, corporations and even farmers earn billions of rupees. This was unimaginable a decade ago.
So what is this thing called Carbon Credits? Is it similar to a credit card where the money is replaced with carbon and where spending is replaced by buying? Not quite, but that’s not very far from the truth either. Please read on.
Carbon credit is a part of an international emission trading norm. They provide incentives to companies or countries that emit less carbon. The total annual emissions are capped and the market allocates a monetary value to any shortfall through trading. Businesses can exchange, buy or sell carbon credits in international markets at a prevailing market price.
India and China are likely to emerge as the biggest sellers and Europe is going to be the biggest buyer of carbon credits. One fact which contributes to this divide is the huge populations of India and China which effectively reduces the carbon per-capita of those countries.
Last year, the global carbon credit trading was estimated at $5 billion, with India's contribution at around $1 billion. India has generated some 30 million carbon credits and has roughly another 140 million to push into the world market.
Waste disposal units, plantation companies, chemical plants and municipal corporations can sell carbon credits and make money. Carbon, like any other commodity, has begun to be traded on India's Multi Commodity Exchange.
A little history
Now why did someone even think up of this? What was the need?
As nations have progressed technologically, they have been emitting gases which result in global warming. A few decades ago a debate started on how to reduce these emissions. The result of these discussions was an agreement which goes by the name “Kyoto Protocol”.
The Kyoto Protocol created a mechanism under which countries that have been emitting more carbon and other gases (greenhouse gases also include ozone, methane, nitrous oxide and even water vapour) have voluntarily decided that they will bring down the level of carbon they are emitting to the levels which prevailed in the early 1990s. The time-span for effective reductions in the carbon emission levels until the final goal has been set from 2008 through 2012.
A company/entity has many ways to reduce emissions:
- Reduction of greenhouse gases by adopting new technology
- Improving upon the existing technology to meet the new norms for emission of gases.
- Tie up with developing nations and help them set up new technology that is eco-friendly, thereby helping developing country or its companies 'earn' credits.
The process angle
India, China and other Asian countries have the advantage as developing countries under the assumption that the penetration of technology required for really high emissions of greenhouse gases have not yet occurred on a wide scale. Any company, factory or farm owner in India can get linked to United Nations Framework Convention on Climate Change (UNFCCC) and inform themselves about the 'standard' level of carbon emission allowed for them. The lesser the carbon emitted (lesser than the UNFCCC norms) the more the carbon credits which could be earned.
The credits could then be bought over by the companies of developed countries -- mostly Europeans. Interestingly, the United States has not signed the Kyoto Protocol.
For instance, assume that British Petroleum is running a plant in the United Kingdom. Say, this plant is emitting more gases than the accepted norms of the UNFCCC. A possible measure then could be a tie up with its own subsidiary in, say, India or China under the Clean Development Mechanism (CDM). It can then buy carbon credits by making the Indian or Chinese plant more eco-savvy with the help of technology transfer. It could also tie up with any other company (like Indian Oil for e.g.) in the open market.
Every December including December 2008, an audit would be done to ascertain the efforts put in by the signatories towards meeting the norms. China and India are ensuring that new technologies for energy savings are adopted so that they become entitled for more carbon credits which in turn would mean that they could sell their credits to the countries which need them. Thus a market was created. Naturally, since 2012 is the set deadline to meet the norms the coming five years should witness a lot of carbon credit deals.
The business angle
This entire process was not understood well by many. Those who knew about the possibility of earning profits adopted new technologies, saved credits and sold it to improve their bottom-line. But other companies did not apply to get credit even though they had latest eco-friendly technologies in place. Some companies used management consultancies to make their plan greener. These management consultancies then scouted for buyers to sell carbon credits. It was a bilateral deal.
However, the price to sell carbon credits at was not available on a public platform. The price range that people were getting used to was about Euro 15 or maybe lesser per ton of carbon. Today, one ton of carbon credit fetches around Euro 22. It is traded on the European Climate Exchange.
The Indian government has not fixed any norms nor has it made it compulsory to reduce carbon emissions to a certain level. So, people who are coming to buy from Indians are actually financial investors. They are thinking that if the Europeans are unable to meet their target of reducing the emission levels in stages every year till 2012, then the demand for the carbon credits would naturally increase and thus would arise the margin of profitability in the whole deal. Therefore the investors are willing to buy now to sell later. The carbon credits themselves are in the form of electronic certificates. But only those companies that meet the UNFCCC norms and which adopt new technologies would be entitled to sell carbon credits.
There are set parameters and detailed audits before one can get entitled to sell carbon credits. In India, already 300 to 400 companies have accumulated carbon credits after meeting the UNFCCC norms.
In the short-term, large investors are likely to be the main players in the market and later banks are expected to get into the market too. Quite clearly someone will have to hold on to these big transactions to sell at the appropriate time.
According to the UNFCCC, the polluters cannot buy 100 per cent of the carbon credits they are required to reduce. They may buy only 25 per cent of carbon credits from developing countries. The rest would somehow have to be made up for by incubating new technologies at home.
However, like in the case of any other asset, the price of carbon credits is determined by a function of demand and supply. Since it’s already known that the polluting countries must meet the norms by 2012, it is anyone’s guess as to how much credit will be available in the market at that time. To what extent would norms be met by European companies? Would they be successful? Do they care enough to make serious efforts?
It is possible that some governments might tinker with these norms if the targets could not be met. If these norms are changed, prices can go through a correction. But, as of now, there is a very transparent mechanism in which the norms for the next five years have been fixed.
But the positive in this whole scenario is that the governments who came together to set the norms and subsequently became the first signatories of the Kyoto Protocol, are the ones who need to work hardest at reducing their carbon levels. Many of their industries are already on their way to meeting the target.